Accounting essentials for charity and NFP leaders

But let’s be realistic. Many leaders have come through program management, community services, fundraising or other professional disciplines. Understanding the numbers doesn’t necessarily come naturally.

In our role, we understand that leaders don’t need to become accountants, but they should feel confident interpreting financial reports and asking informed questions.

With that in mind, let’s explore four accounting fundamentals that can make financial reporting easier to understand and considerably more useful.

One of the more important accounting concepts to understand is the difference between cash and accrual accounting.

Cash accounting records income when cash is received and expenses when cash is paid. It’s relatively straightforward and can work well for smaller organisations with uncomplicated financial arrangements.

Accrual accounting records income when it is earned and expenses when they are incurred, regardless of when money changes hands. Consider a charity that receives a $10,000 invoice in June but doesn’t pay it until July.

Under cash accounting, the expense appears in July. Under accrual accounting, the expense is recognised in June because that’s when the cost was incurred. Why does this matter?

Accrual accounting provides a more complete picture of financial performance, particularly for organisations managing multiple programs, funding agreements and outstanding financial commitments.

However, leaders must also understand that a reported surplus doesn’t necessarily mean there is money sitting in the bank. Surplus and cash flow are two very different things. Our previous article on cash and accrual accounting is a great place to start for understanding this topic.

Quality financial reports require accurate financial data. There’s an old saying in accounting: garbage in, garbage out. While it’s not particularly elegant, it’s accurate. Financial reports are only as reliable as the information used to prepare them. Every invoice, payroll transaction, donation, grant payment and expense contributes to the financial picture.

For charities and NFPs, accurate classification is particularly important.
Imagine an organisation operating three community programs, each with separate funding arrangements. If expenses are allocated to the wrong program, the organisation’s overall expenditure might be correct, but the individual program reports could be misleading.

This will create problems with budgeting, funding and management decisions. Good financial data relies on several straightforward processes:

• Correctly allocating income and expenses to programs and funding streams.
• Submit invoices and supporting documentation promptly.
• Maintaining consistent transaction coding and review procedures.
• Reconciling financial records regularly.

It is important to understand that accurate financial reporting is not solely the responsibility of the finance team. Everyone who contributes financial information has a role to play. In our recent article on accurate reporting data, I discuss the concept that quality financial reporting starts long before the report reaches the boardroom. This article is well worth a read for any leader or board member who wants to better understand their organisation’s financial management processes.  

Most of us know the importance of preparing an annual budget. However, just like in our domestic situation, the budget needs resilience and some flexibility built in. It should never be part of your organisational structure for a budget to be approved in June and forgotten about until the following year.

A good budget is a working financial plan that connects an organisation’s resources with its operational priorities. It should consider anticipated income, staffing costs, program expenditure, funding commitments and potential financial risks.

One particularly useful process is budget variance analysis. This involves comparing actual financial results against budgeted figures to identify differences.

For example, a program might be $20,000 under budget halfway through the year. That sounds positive, but what if the underspend reflects delayed recruitment or services that haven’t been delivered? What does the program’s funder think of this, and does this impact future funding?

Equally, an overspend isn’t necessarily evidence of poor financial management. It may reflect increased demand or additional activities supported by new funding.

The important question isn’t whether expenditure is above or below budget. It’s understanding why. Regular budget reviews, supported by cash flow forecasts, allow leaders to identify emerging issues and make adjustments before they become significant problems.

Financial reports contain terminology that can seem unnecessarily complicated. However, understanding a few commonly used terms can help leaders interpret the numbers. For example:

• Assets: Resources the organisation owns or controls, including cash, equipment, property and investments.
• Liabilities: Financial obligations, including unpaid supplier invoices, loans and employee leave entitlements earned but not yet paid.
• Accounts receivable: Money owed to the organisation, such as outstanding invoices.
• Accounts payable: Money the organisation owes to suppliers and service providers.
• Restricted funds: Funding that must be used for a specified purpose, subject to donor or funding conditions that are legally enforceable.
• Unrestricted funds: Funding available for the organisation’s general purposes, within its charitable objectives and obligations.

These terms help leaders interpret financial statements and understand what resources are genuinely available.

A healthy bank balance might look reassuring. However, if much of that money relates to restricted grants or upcoming liabilities, the organisation’s financial flexibility may be considerably smaller than it first appears. In a previous article, I discussed three key accounting terms: restricted funds, unrestricted funds and fund accounting. This article explains these concepts in more detail, and I’m sure you’ll find it easy to understand and insightful.

While financial reporting is a primary function of compliance, it is also an excellent tool for understanding the organisation’s story and assisting leaders in making better, more informed decisions.

A financial report should help charities and NFPs understand performance and recognise risks. Beyond meeting compliance and governance requirements, the people who prepare them and can communicate the outcome in clear, relatable language will help you become a more informed and valuable leader.

I hope you find this article relevant and helpful to your needs. If your charity or NFP organisation’s turnover is $1M or more and you think you could benefit from an outsourced CFO or finance department, Accounting For Good has the expertise and experience to help your organisation make a difference.